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Soros: Euro Crisis Is Lethal, A Break Up Is Possible

Billionaire investor George Soros is very worried about the Euro Zone, and he’s asking leaders there to take radical action before it’s too late.

It was just over a month ago that the European Central Bank eased the fears of investors around the globe by announcing a second round of loans to banks in the Euro Zone. But cheap money just isn’t enough to end the region’s problems–particularly for Italy and Spain whose bond yields have been been worrying investors this week and sparked fears that the latter may need a bailout.

Those are scary words from the legendary investor whose own net worth stands at $20 billion. It’s not the first time Soros has warned of the lingering problems in Europe. After the first round of LTRO Soros said the deal would only last a short time, from one day to three months.

There have been plenty of calls for a breakup of the Euro Zone but little action because of the perceived difficulty. Soros says though that a break-up is more possible these days than in the early days of the debt crisis. Why? Because as the crisis has progressed countries have been forced to act and behave along national lines. He notes:

The LTRO enabled Spanish and Italian banks to engage in very profitable and low-risk arbitrage in their own countries’ bonds. And the preferential treatment received by the ECB on its Greek bonds will discourage other investors from holding sovereign debt. If this continues for a few more years, a eurozone break-up would become possible without a meltdown – but would leave creditor countries’ central banks holding big claims that would be hard to enforce against debtor countries’ central banks.

One of the barriers to a real fix in the region is Germany’s central bank, Soros writes in opinion piece. The Bundesbank is guarding against a breakup of the Eurozone to protect its own losses. He writes:

The Bundesbank has seen the danger. It is now campaigning against the indefinite expansion of the money supply, and it has started taking measures to limit the losses it would sustain in a break-up. This is creating a self-fulfilling prophecy: once the Bundesbank starts guarding against a break-up, everybody will have to do the same. Markets are beginning to reflect this.

The Bundesbank is also tightening credit at home. This would be the right policy if Germany was a freestanding country, but the eurozone’s heavily indebted members badly need stronger demand from Germany to avoid recession. Without it, the eurozone’s fiscal compact, agreed last December, cannot possibly work. The heavily indebted countries will either fail to implement the necessary measures or, if they do, they will fail to meet their targets because of collapsing demand. Either way, debt ratios will rise, and the competitiveness gap with Germany will widen.

Soros calls existing policies counterproductive and suggests a radical revision to the rules governing the region. His guidelines: modify the existing fiscal charter agreed to by 25 of the 27 EU member with revisions about the types of debt that are accepted. He also proposes that the agreement, which requires member states to reduce their public debt annually by 1/12 of the amount by which they exceed 60 percent of GDP, reward good behavior by taking up those obligations.

“By rewarding good behaviour, the fiscal compact would no longer constitute a deflationary debt trap. The outlook would radically improve. In addition, to narrow the competitiveness gap, all members should be able to refinance existing debt at the same interest rate. But that would require greater fiscal integration. It would have to be phased in gradually,” he writes.

But even Soros knows that his “radical revisions” won’t go over well with Germany. He acknowledges that the Bundesbank “will never accept these proposals.”

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Even the “Father of the Euro” Jacques Delors whose EU planning commission had created the common currency, recently told the London “Telegraph” in an interview that the Euro is now doomed. His commission had carefully prepared all the rules and restrictions, he said, but Europe’s politicians had violated them time and again. Sounds familiar.

Yep, I saw this one coming from a mile away. There’s no getting around a common currency for uncommon countries. Now we are at such an unsustainable level, that a breakup would be the best long term option on the table. Europe is caught in a catch-22. They need the global economy to get better, but it won’t get better until the Europe debt crisis is resolved.